Long-Term Instruments

• Debt instruments are directly impacted by interest rate increases because debt instruments are securities on which investors earn interest. These securities take the form of bonds and mortgages. If you hold a debt security to maturity, you receive a return on premium from the debt issuer. However, if you sell the security to another investor before it reaches maturity, you may have to sell it at a discounted price if similar but more recently issued debt securities are available that are paying higher yields.
  
  

Short-Term Instruments

• When rates are rising, many investors move their funds to highly liquid, short-term instruments such as bank-issued certificates of deposit or money market accounts. If rates on short-term instruments are comparable to rates on older, longer-term interest-bearing instruments, most investors choose the liquidity provided by the short-term instruments over the illiquid long-term instruments. Therefore, cash flows into short-term interest-paying investments usually increase when rates are rising.
  
  Prices of short-term bonds are not usually greatly impacted by interest rate rises because investors do not have to wait long to get a return of premium and are unlikely to agree to sell at a discount.
  
  

Consumer Spending

• When interest rates rise, investors have to spend a higher percentage of their money on debt payments because credit card rates, car loan rates and home loan rates start to increase. Consequently, investors have to curtail their other spending due to a loss of spending power. This means people have less money to invest and since stock prices are partially driven by supply and demand, stock prices fall whenever investors have less disposable income.
  
  

Profits

• Aside from supply and demand, stock prices are also driven by the performance of the companies that issued the stock. Investors who rely on dividend income are negatively impacted when dividends are cut and these investors often turn to other kinds of securities when dividend cuts become widespread. When interest rates are rising, borrowing becomes more expensive for corporations as well as individuals and this causes company profits to drop. Lower profits lead to lower dividends and falling stock prices. Therefore, interest rate rises have a negative impact on the value of stocks.